It may be too late for a pound of cure, but half a dozen years after the bursting of the housing bubble helped precipitate the Great Recession, the U.S. Consumer Financial Protection Bureau (CFPB) has finally gotten around to offering a few ounces of prevention.
Under sweeping new rules passed last week, the 18-month-old federal agency moved to help protect consumers from the worst sorts of predatory lending practices and shoddy underwriting standards that helped cause a dramatic increase in mortgage delinquencies and consequently the country’s recent foreclosure crisis.
Lenders Will Have New Standards
The Ability-to-Repay rule, which goes into effect in January 2014, will require that mortgage lenders obtain and verify all the information necessary in order to determine whether or not a borrower actually has the financial ability to pay back a mortgage. At a minimum, lenders must now consider eight underwriting standards:
- The borrower’s current or reasonably expected income or assets
- The borrower’s current employment status
- The borrower’s credit history
- The monthly payment for the mortgage
- The monthly payments on any other loans associated with the property
- The monthly payment for other mortgage related obligations (such as property taxes)
- Other current debt obligations, including alimony, and child support
- The monthly debt-to-income ratio or residual income the borrower would be taking on with the mortgage
In other words, lenders will now be obliged to do what they should have been doing all along, i.e. actually qualifying borrowers before selling them a mortgage.
But why is it necessary to promulgate rules whose common sense suggest the minimum due diligence that any bank or lender would be expected to perform before issuing a loan? Because recently, it seems, bankers cared more about working around the rules to make money than they did about making money within the rules.
How the Mortgage Business Turned Bad
In the good old days, a bank might have held onto a quality mortgage for the length of the loan, depending on a faithful and consistent repayment to make a profit. Naturally, before it made the loan it evaluated carefully the borrower’s capacity to repay it.
That all changed during Wall Street’s go-go years. Long-term loans lost out in favor of fancy and complex financial instruments like collateralized debt obligations that sucked up every bit of mortgage-backed debt that banks couldn’t grind out fast enough and credit default swaps that lured investors into believing that their bets were covered.
This new financial environment encouraged lenders to move as many bad mortgages out the door as possible. The incentive to practice even the most rudimentary principles of prudent lending often went by the wayside.
After all, if a mortgage was going to be securitized, sliced, diced and sold to investors even before the ink was dry, what difference would it make to the bank if any particular loan was under-investigated, undocumented, and overly risky? Who cared if it blew up somewhere down the road? That would be someone else’s problem.
And knowing there was little downside to offloading these potentially toxic mortgages quickly, lenders upped the ante. They loaded their loans with exorbitant upfront points and fees, offered deceptive teaser rates that masked their true costs to borrowers and came up with all sorts of complicated bait-and-switch products. (For instance, the interest-only and negative-amortization loans that were tied to balloon interest and/or principal payments a few years after the original lenders were safely a couple of degrees of separation away from their customers.)
Protecting Borrowers from Themselves
While the new CFPB rules should help protect future borrowers from sloppy and unethical lending practices, they may also have the effect of protecting consumers from themselves.
Because while nobody can deny that many mortgagers were victimized by rapacious lenders or that many home loans became delinquent because of a crashing economy, far too many borrowers were victims of their own unrealistic dreams, imprudent decisions and outright deception when supplying financial information.
In many instances, both borrower and lender colluded in brewing the toxic mix of specious information and cooked numbers that eventually exploded in the subprime delinquency disaster that brought the economy to its knees.
The new rules have placed the burden of proof when it comes to qualifying a loan application squarely on the shoulders of the lenders, while granting consumers a little more leverage in their capacity to sue banks if they can prove that their own finances were not sufficiently vetted and found sound, before being sold a mortgage.
Therefore, beginning in 2014 the paradigm will no longer be, “Buyer, beware,” but rather, “Lender, be careful.”